Tax reform part of broader plan

July 18, 2013

A few weeks ago, I was interviewing one of North Carolina’s senior Democratic statesmen for my upcoming biography of former Gov. Jim Martin. Not surprisingly, the interview occasionally veered from the events of 20 years ago to the events of 2013.

“John,” said the Democratic politico, “you and I have very different views” about the state’s role in promoting economic growth. While taxes need to be “reasonably competitive,” he said, what really matters is education and infrastructure. “But your view is that if you just cut taxes a lot, you’ll be more successful.”

I responded that I didn’t actually see things that way, which surprised him. I explained that I and most other conservatives see tax reform as only part of a broader, evidence-based strategy for economic recovery, a strategy that also includes regulatory relief, education reform, and smarter investment in infrastructure.

As the details of the tax-reform deal struck by legislative leaders and Gov. Pat McCrory began to emerge, it struck me that many North Carolinians may be in the same boat as my Democratic friend was. Having heard months of spirited debate among Republicans about taxes, they may have come to believe GOP leaders are counting on tax reform alone to produce their promised “Carolina Comeback.”

That’s like letting your eyes be drawn to a busy corner rather than taking in the entire picture. While it did take weeks for the House and Senate to overcome their differences on tax-reform details, lawmakers were simultaneously passing an important change to North Carolina’s transportation-funding formula and fashioning another major regulatory-reform bill to follow previous measures in 2011 and 2012. They were also seeking to work out a deal on two education issues – school choice and teacher tenure – as part of the 2013-15 budget bill.

In reality, most Republicans agree with their Democratic predecessors about the economic importance of infrastructure and education. Long-term growth comes from investment, from building the financial, physical, and human capital necessary to start and grow successful businesses. Where the two sides disagree is on how states can best foster capital formation. In the past, Democrats tended to focus primarily on public capital, on schools and roads, while worrying less about the private investment that typically accounts for about 80 percent of the economy’s capital stock.

Higher taxes can finance higher levels of public investment, yes. But they can also result in lower levels of private investment to the extent they give entrepreneurs, investors, executives, and professionals a reason to take their capital elsewhere. That might be worth it to a state if the rate of return on the public capital its taxes finance is higher than the rate of return of the private capital it chases away.

Unfortunately, that has not been North Carolina’s recent experience. For one thing, our relatively high tax burden hasn’t just funded public investment. Instead, we’ve spent a lot of it on public consumption such as Medicaid. Moreover, in both education and infrastructure North Carolina has not always spent its investment dollars wisely. Meanwhile, private investment has been weaker here than in most of our competitors, with both taxes and regulations playing a role in hampering the growth of our private capital stock.

Job creation and income gains flow from productivity, which in turn flows from effective investment in facilities, machinery, technology, and know-how. Studies show that state government can play a useful role in building and maintaining public capital – but only if it does so in a cost-effective way so that the resulting taxes don’t inhibit the vast majority of capital investment that occurs in the private sector.

By broadening the tax base and lowering marginal tax rates, particularly on capital formation, the tax-reform bill Republican leaders crafted and pushed through the General Assembly will attract private investment to North Carolina while preserving the state’s ability to invest effectively in public assets such as roads and schools.

They have a plan, in other words. Their critics just have a plaint.

Hood is president of the John Locke Foundation and author of Our Best Foot Forward: An Investment Strategy for North Carolina’s Economic Recovery. It is available at JohnLockeStore.com.